Wall Street Firms Endorse Ethics Standards for Analysts

By GRETCHEN MORGENSON

Published: June 13, 2001

Moving to counter the growing belief among investors that Wall Street research is biased, obfuscating or downright untrustworthy, the nation's largest securities firms announced guidelines yesterday to shore up the ethical and professional standards for their analysts and other employees.

After six months of sometimes fractious negotiations, research directors at 14 Wall Street firms endorsed a set of practices for the industry covering broad areas like analysts' compensation, personal ownership of stocks by analysts and the objectivity of the reports themselves.

''The concerns have been that research recommendations are biased, analyst conflicts undisclosed, their language confusing and their compensation skewed to investment banking,'' said Marc E. Lackritz, president of the Securities Industry Association, which announced the rules. ''These best practices call for clear disclosure and will preserve the independence and objective judgment of Wall Street research.''

The mission statement is simple enough: ''The integrity of research should be fostered and respected throughout a securities firm.'' But in an indication of how far the standards have fallen in recent years, Mr. Lackritz said the guidelines would require at least one change in practices at each of the firms that helped to write the standards.

Robert Olstein, manager of the Olstein Financial Alert Fund and a critic of Wall Street research, called the guidelines ''a step in the right direction,'' though they did not go far enough. ''It's about time they stated that analysts' first obligation is to the investor and not to the firm or their own personal accounts,'' he said.

The guidelines were issued two days before Mr. Lackritz is expected to testify on analysts' conflicts in Congressional hearings, sponsored by Representative Richard H. Baker, Republican of Louisiana. The participating firms included Goldman Sachs, Merrill Lynch, Morgan Stanley Dean Witter, the Robertson Stephens investment banking unit of the FleetBoston Financial Corporation, the UBS Warburg investment arm of UBS of Switzerland and the Salomon Smith Barney investment banking unit of Citigroup.

The guidelines are, of course, voluntary, but were endorsed by the chief executives of the participating firms. ''We are confident that these best practices will be carefully considered and appropriately implemented throughout our business,'' they said in a statement.

Until the late 1990's, analysts operated in relative obscurity, publishing research on companies or industries that they followed. But in the mania for technology stocks that took hold in late 1998, the cheery reports from analysts increasingly helped to draw lucrative investment banking deals to their firms, bolstering researchers' pay significantly. In addition, the researchers' pronouncements, often amplified in television appearances, drove stocks to unheard-of levels and made the analysts popular with individual investors.

But as most of the highflying stocks crashed to earth last year, many analysts continued to recommend the stocks. And as investors toted up their losses, they began to wonder more and more why they had not been warned of these companies' teetering finances or dwindling prospects before disaster struck.

In committing to change the way research is conducted on Wall Street, the large brokerage firms appear to be conceding that public trust in Wall Street was in danger of being irreparably damaged by conflicts of interest that had become all too common.

According to the guidelines, no research employee should report to a member of a firm's investment banking department. Such arrangements were common at Credit Suisse First Boston, one of the participating firms, where the technology investment banking group often presided over technology stock research.

In addition, research analysts should not submit their reports to investment bankers at their firms or to corporate management for approval, common practices at many firms. Drafts of research reports may be shared only to verify facts and only when the research recommendation has been removed.

Analysts' pay should not be directly linked to specific investment banking transactions, the guidelines state. ''Analyst compensation should be based on overall performance of their recommendations,'' Mr. Lackritz said. ''No more do a deal, cut a check. And sales and trading desks cannot direct pay to a certain analyst.''

The guidelines also aim to raise the quality of work by research analysts and the clarity of recommendations. ''Recommendations should be transparent and consistent,'' the firms concluded. More specifically, any rating system employed by a firm should now have clear definitions in every report. One result may be a change in Merrill Lynch's arcane rating system, which has used multiple letters and numbers to reflect such elements as risk in the security or the enthusiasm of the analyst.

For those who have complained that many analysts had stopped making independent assessments of companies' operations and had simply become stenographers, taking dictation from corporate managers, the rules state that earnings estimates should represent ''an analyst's best judgments and should never be bound solely by company input.''

And for investors who believed that analysts played down the risks in some stocks, the guidelines require that valuations and risks of securities be explicitly described. Headline-grabbing forecasts -- like the $1,000-a-share target assigned to Qualcomm in late 1999 by Walter P. Piecyk Jr., an analyst at PaineWebber -- are also addressed. The rules say that price objectives for a stock should be made ''with a reasonable basis.'' Frank Fernandez, director of research at the Securities Industry Association, said the group of brokerage firms ''was riven by the discussion of price targets.''

Disclosure of potential conflicts when an analyst's firm also acts as an investment banking adviser to the company he or she follows must be legible and written ''in plain English,'' according to the guidelines. As a result, these disclaimers will probably be changed to appear in larger-sized type than in the past or on the first page of a report rather than the last.

The guidelines also say analysts should disclose whether they or family members own shares in companies they cover, including private investments made before a company is brought public. And personal trading should be consistent with investment recommendations, the rules say. No selling while recommending that investors buy.

Mr. Olstein, the fund manager, said the guidelines fell short because they failed to define standards of good practice in valuing companies. ''Analysts have to learn to write research reports that develop a valuation for a company as opposed to calling where a stock is going to go to based on crowd behavior,'' he said. ''If you're ethical but you don't know what you're talking about, you're just as lethal as if you have bad ethics.''